2010 BUDGET HEAVILY RELIES ON INTERNATIONAL AID

UNCLAS SECTION 01 OF 03 YEREVAN 000051 SENSITIVE SIPDIS E.O. 12958: N/A TAGS: ECON EFIN ETRD AM SUBJECT: 2010 BUDGET HEAVILY RELIES ON INTERNATIONAL AID YEREVAN 00000051 001.3 OF 003 SUMMARY -------------- ¶1. (SBU) On December 10, 2009 Armenia's National Assembly approved the 2010 state budget. Yielding to the impact of the global financial crisis on revenue collections, the GOAM adopted a budget that is one percent lower than that of 2009, with significant cuts to priority areas like social services and defense. After a 14.4% GDP decline in 2009, the 2010 budget anticipates 1.2 percent GDP growth. The deficit is expected to reach AMD 193.4 billion ($509 million) or six percent of GDP. The deficits this year and last are being financed in large part by international loans, which will double Armenia's debt-service payments and may, absent a return to economic growth, further squeeze urgently-needed social spending. END SUMMARY. ANTI-CRISIS BUDGET HITS SOCIAL SPENDING AND DEFENSE -------------- -------------- ¶2. (U) On December 10, 2009 Armenia's National Assembly passed the 2010 State Budget Law, which it calls an "anti-crisis" and "stabilizing" budget plan. At AMD 935.5 billion (approximately $2.5 billion),it is AMD 9.9 billion ($30 million),or 1.1 percent less than the budget approved for 2009. It includes significant cuts to both social services and defense, two areas the GOAM sought to exempt when it made mid-year reductions of about 10 percent to its 2009 spending plan (actual figures are not yet available) in the wake of a 10.9% decrease in expected revenues. The 2009 budget deficit, bridged by heavy borrowing from international financial institutions (IFIs),was a record 4.7% of GDP. The GOAM forecasts 2010 GDP growth of just 1.2 percent, and even its less ambitious budget will nonetheless be financed in significant measure by IFI loans. ¶3. (U) The budget bill received strong support from pro-government MPs, but was opposed by the small opposition factions. ARF/Dashnaktsyutyun complained that their recommendations were not considered by the GOAM and that the budget wasn't pro-development. MPs from the Heritage fraction were against further accumulation of debt and inefficient expenditures. MACROECONOMIC PROJECTIONS -------------- ¶4. (U) The Ministry of Finance's projection of 1.2 percent GDP growth rate for 2010 compares favorably to the 14.4% decline in ¶2009. The 2010 growth forecast is tightly connected to projected worldwide recovery trends, increased demand for commodities, increased metals prices (mining -- mainly non-ferrous metals -- typically accounts for 17% of Armenia's exports),and an increased inflow of remittances following a 30% percent decline in 2009. Nominal GDP in 2010 is projected to equal AMD 3,214.6 billion ($8.5 billion). ¶5. (U) Despite negative 2009 growth figures for all sectors of economy, the GOAM expects industry to grow by 3.1 percent in 2010, agriculture and services by 2 percent each. Construction, which was the main driver of economic growth for the last ten years, declined by 49 percent in January-October 2009, and is expected to decline by a further 3.9 percent in 2010. ¶6. (U) The twelve-month inflation rate is projected to be about five percent. The Current Account deficit is expected to improve slightly compared to 2009 and equal 12.1 percent of GDP (vs. 11.6 percent in 2008). Despite a drastic decline in both imports and exports in 2009 (40 percent decline in exports and 30 percent decline in imports),the GOAM projects (in USD terms) 14 percent growth in exports and 0.8 percent growth in imports. Budget revenues and expenditures for 2010 are calculated based on an exchange rate of 386.41 Drams per USD (it is currently about AMD 375 per USD). REVENUE PROJECTION -------------- ¶7. (U) The 2010 State Budget Law projects revenues amounting to AMD 742.1 billion ($1.95 billion),or 23.1 percent of GDP, 18.1 percent less than the 2009 budget plan and 1.1 percent less than 2008 actual revenues. Tax revenues (primarily VAT and profit tax) and Customs revenues are expected to account for 76.8 percent of total revenues. An estimated 14.2 percent will come from mandatory social payments, and 5.7 percent from official grants. The deficit of AMD 193.4 billion is expected be covered by loans from IFIs and Russia, as well as by issuance of domestic debt. ¶8. (U) Tax revenues and state duties for 2010 are expected to equal 17.7% of GDP, compared to 17.4% planned and 17.1% actual for 2009 and 16.9 percent actual for 2008. In 2010, taxes and state duties are projected to be AMD 570 billion (USD 1.5 billion),AMD 157.5 YEREVAN 00000051 002.3 OF 003 billion (USD 400 million) less than the amount planned for 2009, yet AMD 29 billion more than the actual amount for 2009. DISTRIBUTION OF EXPENSES -------------- ¶9. (U) The 2010 Budget calls for AMD 935.5 billion in expenditures (approximately USD 2.5 billion),AMD 9.9 billion ($30 million) less compared to the 2009 approved budget. Under the 2010 Budget, the GOAM plans to spend 42.7 percent of total expenditures on the social sphere, including education, healthcare, and social security (compared to 47.1 percent in 2009); 19.1 percent on defense, national security and public order sectors (compared to 22.5 percent in 2009 plan); and 17.7 percent to fund projects of various ministries (compared to 13.5 percent in the 2009 plan. A major component of this increase in ministerial projects is an MCC-supported irrigation project on which the GOAM will spend AMD 23.4 billion ($62 million) in 2010, compared to AMD 10 billion ($26 million) in 2009). Approximately 3.5 percent of the budget will consist of grants to regional budgets, four percent for servicing the public debt (compared to 1.7 percent in 2009 plan) and 2.3 percent to the state reserve fund. SOCIAL SPHERE TAKES A HIT -------------- ¶10. (U) The 2010 budget imposes significant cuts to social services, which the GOAM declared would be exempt from cuts when it deferred 2009 spending in mid-year. The AMD 55.25 billion ($145 million) allocation to the health sector is 16.7 percent less than in last year's budget plan and 2.1 percent less than actual spending for ¶2009. Education, which the GOAM has designated a development priority, will receive AMD 99.9 billion ($263 million),21.3 percent less than in 2009 (8.4 percent less than actual 2009 spending). The social protection sector will receive AMD 244.4 billion ($643 million),about two percent less in 2009. Base pension payments in 2010 will remain unchanged, equal to AMD 8,000 ($21) per month. The average employment pension will be equal to AMD 25,738 ($68), unchanged from 2009. (Note: Pensions are comprised of the "base" plus an employment pension based on the number of years worked. End Note.) DEFENSE BUDGET ALSO REDUCED -------------- ¶11. (U) The defense budget for 2010 will be equal to AMD 135.7 billion (USD 357 million),compared to AMD 149.6 billion in 2009, or 9 percent less. The defense budget will be equal to 4.2 percent of the projected GDP (compared to 3.6 percent in 2009) or 14.5 percent of total budget expenditures (compared to 15.8 percent in 2009). BUDGET DEFICIT FINANCING -------------- ¶12. (U) The 2010 budget deficit will be equal to AMD 193.4 billion ($509 million),approximately six percent of GDP. With tax revenues falling significantly amid the economic crisis, the state budget deficit in 2009 was pushed to its highest level in years, 4.7 percent of GDP. In the last five years Armenia's budget deficit was below 2 percent, equal to 1.21 percent in 2008 and 0.13 percent on ¶2007. Armenia's history of low budget deficits is one reason that IFIs have been willing to lend the country over $1.5 billion to date. ¶13. (U) In June 2009, the Armenian parliament adopted amendments to the Law on the Budgetary System, increasing the allowable budget deficit level from 5% to 7.5%. While significantly higher than in previous years, the IMF considers six percent a reasonable deficit level, especially during recession periods, when it is important not to cut social expenditures. ¶14. (U) Under the 2010 budget law, 51.5% of the deficit will be financed from internal sources, including AMD 30 billion (USD 79 million) from sale of treasury bills. Concessional loans from international organizations and foreign governments will be used to finance the remaining 48.5 percent of the budget deficit. (Note: The GOAM had estimated a 2009 deficit of 7.5% of GDP, with a light improvement -- to six percent -- in 2010. A 2009 actual deficit of 4.7% suggests that 2010 will see an even lower deficit as percentage of GDP; however, the GOAM has not yet revised its estimate of six percent. End Note.) EXTERNAL PUBLIC DEBT DOUBLES -------------- ¶15. (U) During 2009 the GOAM secured over $1.5 billion in loans from the IMF, World Bank, ADB, Russia and other foreign sources to counter the adverse effects of the global economic crisis. Fitch YEREVAN 00000051 003.3 OF 003 downgraded Armenia's long-term foreign and national currency Issuer Default Ratings to "BB-" from "BB" in 2009. Armenia spent USD 73 million in 2009 servicing its external debt. In 2010 external debt servicing will reach $114.3 million, or 7.7 percent of total exports. According to IMF projections it will reach 20.9 percent of total exports in 2013. ¶16. (U) Armenia's external public debt is projected to equal $3.1 billion at the end of 2009 (compared to $1.58 billion as of December 31, 2008). In 2010 Armenia will receive around $536.3 million of foreign financing, which will increase the external public debt to $3.57 billion. According to the GOAM's preliminary estimates, Armenia's public debt will be equal to $4 billion by the end of ¶2010. The external debt will increase from 13% of GDP at year-end 2008 to 36.1% for 2009, and 44.3% at the end of 2010. The IMF considers Armenia's current debt levels manageable given the GOAM's history of low deficits. COMMENT -------------- ¶17. (SBU) Despite efforts to stimulate the economy through its anti-crisis programs using foreign credits, Armenia closed the 2009 financial year with a huge economic contraction and a doubling of foreign debt. The 2010 budget, which also relies heavily on foreign credits, is probably sufficient to meet the minimum social needs of the country, though it represents a discouraging backtracking from efforts to expand the social safety net to the most vulnerable populations during a time of severe economic crisis. In order to be able to service its foreign debt, Armenia will soon need to see stronger GDP growth. The GOAM will also need to continue to improve its tax collection system to increase compliance and bring businesses out of the shadow economy. END COMMENT. YOVANOVITCH